RBI To Withdraw All FDI Pricing Guidelines!

This morning when I alerted a few lawyers to the news that RBI is withdrawing all FDI pricing guidelines – some of them asked if I was playing an April Fool’s Day prank on them. Others were stunned into silence. The disbelief and surprise are not unexpected. After all this heralds not just a new regulatory policy but also a dramatic change in mindset at the regulator.

For decades India has prescribed pricing formula or guidelines for the entry and exit of foreign investors in unlisted Indian equity. At first the pricing formula was a CCI (Controller of Capital Issues) determined formula. The CCI formula was, roughly speaking - an average of net asset value and profit earning capacity value – making it a valuation based on past performance. The grouse was that it allowed foreign investors to under-price Indian equity. In 2010, RBI based the pricing guidelines on DCF or ‘discounted cash flow’ valuation – a valuation method based on future performance. More recently, in January this year, in an effort to permit call & put options in shareholder agreements with foreign investors but to block assured returns – the RBI said such options were allowed on unlisted equity only if the exit price did not exceed an RoE based price. But there was one relaxation in the January circular that was a sign of things to come. When it came to the pricing of options on compulsorily convertible debentures and preference shares, RBI permitted the use of ‘any internationally accepted pricing methodology’.

Padmanabhan: …this is just one stage before we make all the instruments based on internationally accepted pricing norms. We wanted to address the issue of the FDI having these options on listed company separately because there were lot of problems with that. We have addressed that. We are in discussion with the government obviously to make these pricing guidelines uniform across. So it is a matter of time before this uniformity sets in. I agree that as of now there is a little difference between what is there for the CCDs and CCPS, but it is a matter of time I hope before we would be able to have uniform pricing guidelines across all instruments.

Doshi: You said you are in the process of unifying- so I just want to make sure you want to move CCPS/CCD to ROE based as well or you want to convert unlisted to internationally accepted pricing?

Padmanabhan: Please remember that the way forward at least as far as the FEMA guidelines are concerned is to liberalize. They do not go back to a more regimented or stricter kind of calculations or the formula. So these are two separate regimes as it exists today. You would also know that there is lot of work taking place. Government and Reserve Bank of India (RBI) are looking at revamping the entire FDI guidelines to make it simpler. So today the problem that has cropped up is these are two different regimes and as a result of this, two separate pricing guidelines apply. So our idea is to make this all uniform as quickly as possible. The work is on. When that will be completed I do not know, but it will be very quickly I hope. Having said that the specific answer to your question that whether it will be more strict or liberal, it will be towards further liberalizing.

The liberalization has come qquicker than most of us expected. Today, on April 1st, in its monetary policy statement, the central bank & regulator pulled a surprise. It said ‘as regards foreign direct investment (FDI), it has been decided to withdraw all the existing guidelines relating to valuation in case of any acquisition/sale of shares and accordingly, such transactions will henceforth be based on acceptable market practices. Operating guidelines will be notified separately.’

AZB’s Managing Partner Zia Mody told me this will ‘boost’ FDI.

Zia:…probably the RBI is taking a view that it will put behind the ghosts of the past as to whether there is a side deal in every transfer. It will move to a situation where it will at least put its first step forward to trust the parties and will have some backup in terms of getting appropriate certifications from chartered accountants or other intermediaries to back the fact that the valuation has been based on acceptable market practices, which I think will be detailed a bit more later.

Menaka: Would you say this would come as a big boost to FDI, both the fact that the RBI is now taking a far more liberal, modern view of how to look at the entry and exit of FDI and also the fact that there would be less paperwork and more market based practices?

Zia: Yes, I think that foreign direct investors will feel that they are not always the last person to be looked after. So far, the philosophy has very often been that the foreign party comes in at the highest price and exits at the lowest price or at least that is how they feel.This will definitely give a boost to them, the thinking that if two parties negotiate a market value and a bargain between them then it will not be a regulator that comes in way provided the valuation is not ridiculous…

And PwC Partner & ED, Vivek Mehra said he ‘welcomes’ the move.“I welcome the move. Earlier they (RBI) were being prescriptive by saying they (investors) should follow the DCF method and for ‘put’ options on equity shares they said RoE (Return on Equity) – which was quite a bizarre method of valuation - infact it’s not an acceptable method of valuation. I think now they have talked about ‘acceptable market practices’, which I imagine means that the valuer will exercise his judgement as to what is the globally accepted method of valuation for those particular facts and circumstances. And the pricing guidelines would need to comply with that.”

The comments are cautiously optimistic ahead of operational guidelines being released. Many questions came up in the many conversations I had with lawyers and regulatory experts today. The most important question being – will RBI continue to regulate against ‘assured returns’? The regulator has been clear about its opposition to all options delivering assured returns as that amounts to ‘debt masquerading as equity’. Hence it first disallowed call & put options and thereafter, once they were allowed, imposed the RoE linked price limit. So how will this opposition reflect in the new guidelines?

One lawyer cracked that ‘Indian promoters are going to be rather un-happy’. The joke being many promoters have used the RBI’s position to escape options they didn’t want to honour. Another smsed “They see light”. Yet another said “will wait till fine print emerges but boom time once again I guess”.

“Excellent news”“What!!! Wow”“Wow”“Wah” …is how the rest reacted.

I wonder if they’ll say the same once the operational guidelines are released? But till then it deserves to be said that the decision to do away with FDI pricing guidelines marks a big shift in RBI’s otherwise control and command regulatory approach. Foreign investors – be it corporate joint venture partners or venture capital funds – will be delighted to hear this news. They too will be waiting to see if the operational guidelines deliver on the promise of an India experience that is lighter on regulation, bureaucracy and paperwork.